Thursday, September 26, 2013

I had the opportunity to meet Mike Maloney at a real estate conference back in 2006 in New York. He had a small booth set up with a few of the people who worked for his company, and he was discussing the financial markets and precious metals with anyone who was interested to speak with him.

The booth was completely empty. Everyone at the conference, close to 80,000 people, were packed into other booths and rooms learning about and buying products on how to invest in real estate. The thought of putting money into precious metals back at the time was never even discussed.

When I met Maloney I had already been investing in precious metals for over a year, and I was spending all available free time pouring through every book I could get my hands that discussed monetary history. I walked over to Mike and spoke with him for about 25 uninterrupted minutes regarding the financial system and what we both thought would be occurring in the years ahead. Since, at the time, I literally had no one in the world to talk to about these topics, it was heaven for me.

Fast forward to today and Maloney is now the headline speaker at major conferences around the world (such as the ones featured in the video below). In part 3 of this video series Mike walks through the (mostly unnoticed) changes occurring with the current dollar standard, China's accumulation of physical precious metals, and the incredible growth in the money supply.

Wednesday, September 25, 2013

The actual magnitude of what took place last week, the Federal Reserve's decision not to taper its current $85 billion per month QE program, is very small.

After all, what is the difference between $75 billion, $80 billion, or $85 billion per month of U.S. government debt and mortgages being purchased every month in a $16 trillion economy? Very little.

The real importance comes from the market's perception of what it means for the Fed's future movements. Many analysts throughout the country that have bought into the artificial "recovery," felt that the small taper would be a sign that the Fed had finally begun its exit program.

Before moving forward, let's briefly define what exit strategy actually means. Back in early 2009 when the Fed announced its first QE program (QE 0 occurred during the fall of 2008 during the panic when the Fed was backstopping everything in the markets), the Fed concurrently discussed the much touted exit strategy saying that when the crisis period had passed they would not only stop buying assets; they would sell them back into the market. This process would normalize their balance sheet back down to pre-financial crisis levels.

Here is a quick look at the Fed's balance sheet growth from 2003 ($720 billion) to August 2008 ($900 billion). I remember people discussing at the time how this rapid growth was troublesome.

The next graph shows the Fed's balance sheet today. Instead of selling the original assets back into the market to get back down to the $900 billion level (this was being discussed relentlessly by the Fed throughout 2009 and 2010 - I am not making this up), the balance sheet has mushroomed up to over $3.6 trillion. What would occur if the Fed were to "exit" and sell $2.7 trillion of assets into a market where they are the only buyer? I'll leave that up to your imagination.

Those with a firm understanding of the financial markets know that what has taken place since early 2009 and the current world will live in today is a complete (and temporary) fantasy. Thus far into the Fed's programs we have only experienced the positive effects of the relentless QE heroine drip:the initial high. Stock markets have surged to new record highs, with technology IPO's now once again entering the market and doubling the first day (remember 1999?). Any correction along the way has been instantly met with Fed talk of more stimulus. This is now known as the "Bernanke Put."

The bond markets have taken the bait and yields fell to the lowest levels in American history, before rising the second half of this year (rates are still incredibly low).

Real estate investors, and to a smaller degree actual home owners, have also taken the bait. Wall Street has entered the markets with the Fed's free money to purchase thousands of homes. Regular home buyers are beginning to come off the sidelines and take advantage of the low cost of a monthly mortgage.

When the Fed tried to calm the market euphoria back in May with the "taper talk" the markets around the world went into a convulsion. Emerging markets were rocked as they felt there would be less printed capital flooding off the shores of America into their booming asset markets. Asset markets within the United States revolted, as stocks and bonds sold off simultaneously.

Understanding that a rise in rates, a falling stock market, and a reversal of the new real estate bubble would remove the artificial recovery cloth that has been placed over the eyes of the many, the Fed panicked last week and announced that the taper was off.

It is pointless to spend time arguing over why it occurred when you understand the bigger picture; the Fed has painted itself into a corner and is now trapped.

The markets today still believe that the Fed has complete control over asset prices, but this belief is completely false. As a perfect example, the 10 year treasury yield was under 1.5% during the summer of 2012 and has since doubled during the QE forever program announced just a few months later. When the Fed does lose control over the equity, bond, or currency market, one of which will ultimately break, it will be chaos in the markets. The only thing holding them together at this moment is misguided belief and confidence.

Why will the Fed ultimately lose control? The Fed's asset purchases, on a fundamental basis, are negative for the asset classes that are rising. Most market participants don't remember this today, but back in the 1970's when the Fed's balance sheet was announced, a rise in the money supply would create a sell-off in the bond market. That is the exact opposite of what occurs today. Why?

The Fed printing money and purchasing bonds dilutes the value of the underlying currency that the bonds are denominated in. That means you will be paid back in the future with dollars that are worth less today. Since you are purchasing a future income stream this is the only thing that should fundamentally matter when making the investment decision.

Today this simple concept has been completely lost, mainly because bonds today are bought and held to flip for capital gains, not an income stream. This is identical to the mindset that entered the real estate market during the mid 2000's. Investors cared little about future income streams because they could always sell the asset tomorrow at a higher price and exit the market.

The same thought process is used today with stocks. Investors only see that printed money entering the financial system is new money available to purchase stocks. They do not see that new money causes negative impacts on one side of the balance sheet of those same companies (cost to create their goods), at the same time diluting the purchasing power of the consumers who purchase those goods. The following graph (blue line) shows that the real median household income (adjusted for inflation) in America since 2000 has fallen 7.3%.

With corporate profits at all time record highs (corporate profits always mean revert), investors are betting on price to earnings multiple expansions to create future gains. Investors buying stocks today know (hope?) that they can just sell them tomorrow at a higher price because investors will continue to pay more for the same (or lower) profit stream.

The Fed has stretched this fantasy so far, like a rubber band expanding or a beach ball being held under the water, that we are close to the point where the markets will mean revert to wash out the mal-investments that have been created. By close, I mean it's likely that point could occur within the next 18 months. Bubbles have a tendency to go on far longer than rational market participants can imagine, and we are currently in the largest financial bubble in history - by far. We have a stock bubble (fueled again by record setting margin debt), a real estate bubble (prices rising due to artificially low interest rates, temporary Wall Street money, and not rising incomes), and a bond bubble which dwarfs the first two in size and magnitude.

Everyone is once again moving to the point where they are "all in." Every day that these asset prices move higher provides another layer of fear that is removed from market participants. The concept of holding cash is not only not considered today, it is laughed at. The idea of holding commodities such as precious metals and agriculture is even more obscene.

One of the best sayings in the financial markets is that "the bull climbs up the stairs and the bear jumps out the window." While we have seen a slow and steady rise for over 5 years, the reversion of this artificial market could occur in a matter of weeks.

In the meantime, as asset prices continue to go higher and higher as the Fed pumps and pumps, fundamental concepts such as the ones you are reading here today will continue to seem more and more crazy. For those that do understand what is coming and have taken action to protect yourself, I congratulate you. You will be able to watch the horror unfold from the sidelines and hopefully have the courage to take action when fear is at its peak. That time is coming.

For more on why it is not possible for the Federal Reserve to sell assets into the market (hint: their own balance sheet would implode) see: Why The Fed Can Never Exit

Monday, September 23, 2013

I have been doing a lot of traveling lately combined with my regular (enormous) workload so it has been tough for me to get time to sit down and do some writing. I should have more in the week ahead regarding my thoughts on the Fed's no taper decision and the impact on financial markets, asset markets, and the economy.

Until then, I'll leave you in great hands. First with an interview from the legendary Jeremy Grantham with the Wall Street Journal:

Jim Rickards provided an excellent in depth interview with the Financial Sense Newshour over the weekend. Rickards was one of the very few financial market participants that insisted that the Fed would not taper last week. He provides his reasons why they chose not to taper and what we can expect from monetary policy around the world in the months and years ahead:

The next video comes from Ray Dalio titled "How The Economic Machine Works." Dalio runs Bridgewater Associates and is considered by many to be the greatest hedge fund manager in the world today. Bridgewater Associates become the largest hedge fund in 2011 with $120 billion under management, and Dalio has a personal net worth of over $13 billion.

"We should be careful to get out of an experience only the wisdom that is in it and stop there lest we be like the cat that sits down on a hot stove lid. She will never sit down on a hot stove lid again and but she will never sit down on a cold one either."

- Mark Twain

"It's waiting that helps you as an investor, and a lot of people just can't stand to wait."

- Charlie Munger

"Live as if you were to die tomorrow. Learn as if you were to live forever."

- Gandhi

"One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do. I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I wait for a situation that is like the proverbial shooting fish in a barrel."

- Jim Rogers

"Capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich."

- James Grant

"At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."

- Ben Bernanke, March 2007

"Everything that needs to be said has already been said. But since no one was listening, everything must be said again."

- Andre Gide

"When people are getting richer and richer but they're not actually producing anything, it can't end well."

- Louis CK

"In economics things take longer to happen than you think they will, and then they happen faster than you thought they could."

- Rudiger Dornbusch

"I don't write about what I know. I write to find out what I know."

- Patricia Hampl

"Chains of habit are too light to be felt until they are too heavy to be broken."

- Warren Buffett

"Everyone has a plan until they get punched in the mouth."

- Mike Tyson

"Interest on the debt grows without rain."

- Yiddish Proverb

"You can have comfort, or you can have value. You cannot have both."

- Jim Grant

"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."

- Warren Buffett

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"Men who can both be right and sit tight are uncommon."

- Jesse Livermore

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

-Ludwig von Mises

"Most investors think quality, as opposed to price, is the determinant of whether something's risky. But high quality assets can be risky, and low quality assets can be safe. It's just a matter of the price paid for them."

- Howard Marks

"Whenever you find yourself on the side of the majority, it is time to pause and reflect."

-Mark Twain

"None are more hopelessly enslaved than those that falsely believe they are free."

-Goethe

"The longer the markets disobey basic rules of valuation, the bigger the opportunity for good investors to reap the benefits. Value investing works precisely because markets become dysfunctional at times."

-John Coumarianos

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

-Sir John Templeton

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"People only accept change in necessity and see necessity only in crisis."

-Jean Monnet

Requiring a central bank to print money to increase government's purchasing power invariably ignites a hyperinflationary firestorm. The result through history has been toppled governments and severe threats to societal stability.

- Alan Greenspan

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."

- Henry Ford

"Do you want to sell sugared water for the rest of your life? Or do you want to come with me and change the world?"

-Steve Jobs

"I'd be a bum on the street with a tin cup if the markets were always efficient."

-Warren Buffett

"The market can stay irrational longer than the investor can stay solvent."

- Keynes

"While the government struggles to save one crumbling enterprise at the expense of the crumbling of another, it accelerates the process of juggling debts, switching losses, piling loans on loans, mortgaging the future and the future's future. As things grow worse, the government protects itself not by contracting this process, but by expanding it."

-Ayn Rand, 1974

"The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function."

- F. Scott Fitzgerald

"All our life, so far as it has definite form, is but a mass of habits - practical, emotional, and intellectual - systemically organized for our weal or woe, and bearing us irresistibly toward our destiny, whatever the latter may be."

-William James

"Men it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."

-Charles Mackay

The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge.

- Stephen Hawkings

"Give me control of a nations money supply, and I care not who makes it's laws."

- Amschel Rothchild

Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces.

- Sigmund Freud

Many of life's failures are people who did not realize how close they were to success when they gave up.